Yuan Liquidity Squeeze a Bad Sign for China’s Equity Market

Yuan Liquidity Choke Bad for Stocks
  • China focusing on currency at expense of stocks: Hao Hong
  • Yuan loan rates in Hong Kong surge to seven-month high

The outlook for one of the world’s worst-performing stock markets is getting dimmer.

China’s benchmark equity index was jolted out of its inertia on Monday when the cost of borrowing the yuan in Hong Kong jumped the most in seven months, exacerbating concern about a global selloff. The Shanghai Composite Index tumbled as much as 2.6 percent after having gone 19 trading days without a 1 percent closing move in either direction.

Higher funding costs will weigh on the nation’s shares as the People’s Bank of China seeks to squeeze bears betting against the yuan amid rising odds of a U.S. interest-rate increase, according to Bocom International Holdings Co. The yuan is set to enter the International Monetary Fund’s Special Drawing Rights on Oct. 1 in a validation of the government’s efforts to open up the nation’s financial markets.

"They want the currency to be relatively steady because we’re getting into SDR and they don’t want it to depreciate substantively before that,” said Hao Hong, chief China strategist at Bocom in Hong Kong, one of the few who predicted the start and peak of China’s equity boom. “So you have to give up the equity market. Of all the asset markets, I think the equity market is the least of concern now" to China’s policy makers, he said.

The Shanghai Composite dropped 1.9 percent on Monday, the most since July 27. The three-month Hong Kong Interbank Offered Rate climbed 95 basis points to 4.21 percent, the highest since March, according to Treasury Markets Association data. Gains in the yuan Hibor in January and last August coincided with routs in China’s gauge of so-called A shares as the PBOC sought to defend the currency against further weakness.

"The Hibor rate is a reference for A-share investors," said Wu Kan, a fund manager at JK Life Insurance Co. in Shanghai. "Its surge means an increase in capital costs and that’s bad for equities."

The Shanghai gauge is down 15 percent this year after last year’s $5 trillion selloff burnt investors. Monday’s losses came as shares were buffeted globally amid concern central banks in the world’s biggest economies are questioning the benefits of loose monetary policy. The Hang Seng China Enterprises Index plunged 4 percent in Hong Kong on Monday, the biggest loss since February, and another 0.9 percent on Tuesday.

There’s already concern China won’t ease monetary policy further. Capital outflows spurred by dollar strength will constrain the room for cutting benchmark rates or banks’ reserve requirements, according to Citic Securities Co., the country’s biggest brokerage.

Curbing Risks

China has shown a renewed focus on curbing financial risks lately, with a slew of proposals to tighten rules on wealth-management products, restructuring of listed firms and leverage in the bond market. The nation should take steps to restrain bubble-like expansion in housing markets and tame excessive financial inflows into property, Ma Jun, chief economist of the PBOC’s research bureau, said in an interview with China Business News published Sunday.

Monday’s jump in Hibor came as 12-month non-deliverable forward contracts on the yuan signaled traders were the most bearish on the yuan in almost four months. The currency is Asia’s worst performer this year with a 2.8 percent drop against the greenback to 6.6798 a dollar. Yuan interbank rates dropped in Hong Kong on Tuesday after the city’s monetary authority said in an e-mail on Monday that it has provided yuan liquidity support to banks.

"The PBOC squeezed offshore yuan supply and thus pushed up Hibor, in an effort to increase the costs for bears to bet against the currency," said Ken Peng, an Asian investment strategist at Citi Private Bank in Hong Kong. "Hibor will likely remain elevated around the current level" until the U.S. raises borrowing costs, which Peng said would likely come in December.

Liquidity Demand

The rise in Hibor is probably due to increased demand for liquidity before the end of the quarter, according to Wing Lung Bank treasurer Terry Siu. China’s markets are closed for holidays on Thursday and Friday, as well as during the first week of October.

The increase in borrowing rates comes at a bad time for mainland shares, which have lagged behind their Hong Kong-listed equities.

"Psychologically, the Hibor surge will affect stocks," said Steven Leung, executive director at UOB Kay Hian (Hong Kong) Ltd. "When interest rates go up, stocks suffer."

Before it's here, it's on the Bloomberg Terminal. LEARN MORE